Preferred lenders: setting the record straight: with these institutional/lender partnerships, saving families money and time is the goal.

THE RECENT SCRUTINY OF colleges' preferred lender lists by state and federal officials, while intended to expose unscrupulous student lending practices, has generated a flood of misleading information in the media and in political arenas about a common practice designed to benefit students.

Media reports suggest that the preferred lender list is the result of an "unholy union" between financial aid officers and student loan companies designed to pick the pockets of students and their parents.

As financial aid administrators know, the reality is much less nefarious. These lists are generally developed to save students and parents money and time.

Helping the public to understand how preferred lender lists are developed and used would help dispel some of the myths that have been growing about this common student aid tool. Here's what administrators and staff should know about preferred lender lists, including some things to consider when developing these lists.

WHY A PREFERRED LENDER LIST?

The growing gap between the cost of higher education and the amount of available federal and state aid has caused a rapid expansion of the student loan industry. Schools develop preferred lender lists to help families sort through the ever growing array of available loan terms and conditions and to identify loans with the most favorable borrower benefits and companies with the best customer service.

These lists are designed to be a starting point for families trying to navigate the maze of potential lenders. Financial aid administrators use their intimate knowledge of the student loan industry to choose lenders that generally offer the best products and services to most students, but each student's circumstance is different. So families should be encouraged to do their own research and ask aid administrators and lenders tough questions to ensure they get the loan that is best for them and that they understand the terms of their loan.

HOW THESE LISTS ARE CONSTRUCTED

Financial aid offices that offer lender recommendations to students spend significant time and resources in developing their lists. The National Association of Student Financial Aid Administrators has developed a monograph to help aid offices with this process (see www.nasfaa .org/PDFs/2005/Monograph15.df).

One of the institutions highlighted during the recent wave of criticism of preferred lender lists reviewed proposals from 35 student loan companies to determine which lenders it would feature on its preferred lender list. A nine-member panel reviewed the 10-page proposals and ranked companies based on customer service, borrower benefits and pricing, default aversion, loan delivery flexibility, diversification (value-added products), and life-of-loan servicing.

"It took us three months to complete this process," says an official from this institution. "It was quite laborious but worth every minute to try and offer the best lending options available to our students."

Many students and parents don't have the time or resources to conduct such a thorough review of the plethora of private loan options and companies. Private lenders offer an array of upfront and back-end benefits and interest rates that can vary depending on the student's credit history, intended major, and institution chosen.

Another university mentioned in the recent negative press coverage had students ask the institution to develop a preferred lender list. Students notified the Financial Aid office that they were unhappy with the multiple options for private loans because the process of choosing one was too frustrating and complex, according to a university official. Students felt that navigating the multitude of loan terms should be the Financial Aid office's responsibility. The university decided it was in students' best interest to identify, on behalf of borrowers, a private loan that offered the best combination of terms available.

Some factors the university considered when selecting lenders for their list would never be considered by students and parents. But ultimately these factors benefit the borrower. In addition to the loan rates and benefits, the university considered questions such as:

* Does the lender make FFELP loans? If so, there could be a conflict of interest with the school's Stafford loan volume.

* What is the lender's approval rate? It doesn't matter what the loan terms are if a student can't get approved.

* Does the company offer a deferment option and an interest-only option for in-school periods?

* Is the lender willing to discuss its tiered pricing of interest rates as it relates to credit scores?

Through asking such questions, the university found lenders that met the criteria it was looking for. In addition, these lenders offered to return a small portion of their profit to give to needy students in the form of scholarships. This is known as revenue sharing, and many higher education institutions depend on this money to compensate for stagnant local, state, and federal funding of need-based financial aid.

THE QUESTION OF REVENUE SHARING

Although schools generally use the funds from revenue sharing agreements with lenders to increase financial aid for students, NASFAA President Dallas Martin discourages such arrangements.

"I advise against this practice because it is hard for many in the public to understand the benefits to students that these agreements bring," Martin says. "Since many do not know or understand the details of such agreements, the appearance of a conflict of interest may be unavoidable."

Despite that possible appearance of a conflict of interest, it is hard to criticize institutions for exploring every possible avenue to raise additional money for financial aid.

"Student aid funds--whether coming from the federal or state governments--have not come close to adequately meeting the financial aid needs of students and families," Martin says.

Subsidized federal loan limits for upper-class level undergraduate students and for graduate students have not been increased in well over a decade. Loan limits for lower-class level undergraduates were recently raised by only a modest amount. Students and families are often left with no choice but to use alternative loans, which have higher interest rates and fewer borrower benefits than the federal loan programs.

The rates on private loans also vary depending on a borrower's or loan co-signer's credit score and other factors, such as if the student's major has a higher earning potential. All this makes it harder for students and families to choose a loan company.

THE HIGH PRICE OF THE TRIAL-BY-MEDIA APPROACH

The recent negative publicity of preferred lender lists may help increase transparency in the student loan industry, but at what cost? This media coverage could be undermining students' and parents' trust in the counseling and advice given by financial aid administrators, most of whom are scrupulously honest and forthright and take pride in their adherence to NASFAA's Statement of Ethical Principles.

This mistrust could prove harmful to students who rely on the knowledge and experience of financial aid professionals. If students and families don't think they can turn to Financial Aid offices for guidance, they are more likely to seek advice from questionable sources such as predatory student aid consulting firms, lenders whose marketing approach encourages students to borrow as much as possible, or simply uninformed relatives or neighbors. In fact, one Chicago-based television newscast recently recommended that families consult with their mortgage broker about student loans rather than consulting the student aid office.

Clearly, improving transparency in the student loan process is commendable, but using inflammatory rhetoric that implicates an entire profession only creates distrust and harms the students everyone is trying to help.

Haley Chitty is assistant director of communications at NASFAA, www.nasfaa.org